What Are Restructuring Costs & How Are They Accounted For?
Understand how corporate restructuring expenses are defined, measured, and reported according to established accounting principles for financial clarity.
Corporate restructuring is a major change to a company’s business model, operational setup, or financial structure. These initiatives are undertaken to improve efficiency, increase profitability, or adapt to market shifts. While the goal is long-term benefit, the process generates specific expenses known as restructuring costs. These costs are distinct from the regular, day-to-day operating expenses a business incurs.
Common Types of Restructuring Costs
A significant portion of restructuring costs is dedicated to employee-related expenses. When a company downsizes or closes facilities, it provides severance packages to laid-off employees. These packages can include a lump-sum payment or continued salary based on length of service. Companies may also offer outplacement services, which help former employees find new jobs.
During a restructuring, retaining personnel is important for operational stability. To achieve this, companies use retention bonuses. These are financial incentives offered to key employees, contingent upon them staying with the company through the transition period or until a specific milestone is reached. These bonuses are a direct cost of the restructuring.
Asset-related costs are another major category of restructuring expenses. A company may decide to close a factory or discontinue a product line, rendering associated assets less valuable. In these situations, the company must perform an asset write-down, which reduces the value of the asset on its books to its current fair market value. This is recorded as a charge.
Restructuring plans frequently involve exiting existing contractual obligations, which leads to termination costs. A common example is breaking a real estate lease for a location that is being closed. Landlords require a penalty payment to terminate the lease agreement early. Similar costs can arise from ending long-term contracts with suppliers or service providers.
Beyond these primary categories, other direct costs are associated with the planning and execution of a restructuring. Companies often engage external experts, leading to consulting and legal fees. These professionals assist in developing the restructuring plan, ensuring compliance with labor laws, and managing the overall process. These fees are part of the total restructuring cost.
Accounting Recognition and Measurement
The accounting for restructuring costs is governed by the accrual basis of accounting, which requires expenses to be recorded when they are incurred, not when cash is paid. A liability is recognized on the balance sheet once certain criteria are met. The primary standard, Accounting Standards Codification 420, provides a framework for when these costs can be officially recorded.
A primary requirement for recognizing a restructuring liability is that management commits to a formal plan. This plan must be detailed enough to allow for a reasonable estimation of the costs. It needs to specify the actions to be taken, the business units affected, the approximate number of employees to be terminated, and the expected timeline for completion.
The plan must also be communicated to those affected by it. This communication creates a valid expectation that the company will carry out the restructuring, making the liability official. For instance, one-time employee termination benefits are recognized when the plan is communicated to the employees, not when they are eventually paid.
Finally, the costs associated with the plan must be reasonably estimable. This means the company can make a reliable calculation of the expenses it will incur. For example, severance costs can be estimated based on existing employee contracts or company policies. If a cost cannot be reasonably estimated, it cannot be included in the restructuring liability.
Presentation on Financial Statements
Restructuring costs are presented in a company’s financial statements to provide clarity to investors. On the income statement, these charges are reported as a separate line item. This placement, often within operating expenses, highlights that the costs are not part of the company’s ordinary business activities. This separation allows analysts to assess the underlying profitability of the firm.
The cash flow statement reflects the actual cash payments made for these restructuring activities. While the expense is recognized on the income statement when the liability is incurred, the cash may be paid out over a longer period. These cash outflows are classified under “Cash Flow from Operating Activities.”
The footnotes to the financial statements offer the most detailed information about the restructuring. Companies are required to provide a disclosure that breaks down the major components of the restructuring charge. The footnote will describe the restructuring plan, show the total expected cost, and reconcile the beginning and ending liability balances for the period.